Options Update: Tempur-Pedic Puts Popular Post-Earnings

After the close last night, Lexington, Kentucky-based Tempur-Pedic International
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reported that net income fell 38% to $24.1 million, or 32 cents per share, from $38.8 million, or 49 cents per share, last year. Sales declined 14% to $252.8 million for the quarter. Analysts were looking for a profit of 32 cents per share on revenue of $259.1 million.

“We are facing the most challenging economic environment in memory, and we see no reason to assume the economic climate will recover in the short term,” CEO Mark Sarvary said in a statement. “Therefore, we are taking actions now to further improve our financial flexibility and strengthen the business.”

Those action include suspending the company’s quarterly dividend and redirecting those funds to reduce debt. TPX also said it plans to minimize company spending. Looking ahead, the company said it now believes fourth-quarter sales will fall below prior expectations, with full-year earnings anticipated to arrive between 90 cents and $1 per share.

Surprisingly, TPX shares have surged nearly 6% higher today, despite the lackluster guidance and economic warning. However, the rally hasn’t stopped put traders in the options pits. Specifically, more than 27,000 of these bearishly oriented options have traded on TPX so far, placing the shares on our Intraday Volume Explosion List. As you can see from the chart below, it was the heavy attention that options traders were paying to the TPX December 10 put that caught my eye.

Tempur-Pedic International option volume details

The Anatomy of a Tempur-Pedic Put Position

Diving into the options data, I noticed that nearly all of the TPX December 10 put volume traded at the ask price. Combine this data with the fact that volume at this option easily exceeds open interest, and TPX is likely being targeted by heavy buy-to-open put activity. Running with the put-buying theme, it would appear that a trader purchased 7,700 TPX December 10 puts at 10:38 a.m. Eastern time for the ask price of $3.20. The total outlay for this position would be $2,464,000 — ($3.20 * 100)*7,700 = $2,464,00. That is no small chunk of change! For this trade to reach breakeven, TPX would need to fall about 13.6% from yesterday’s close to $6.80 per share before the options expire on December 19. The maximum loss on this position is limited to the initial investment of $2,464,000.

By entering this trade, the investor is indicating that he expects TPX to fall sharply during the next several weeks, reversing today’s gain of nearly 6%. That said, let’s see if the stock’s technical or sentiment backdrops provide any additional drivers for this trade.

Getting Technical

Looking at a weekly chart of TPX, we find that there is potential for a December 10 put to reach profitability. Since peaking in October 2007, the stock has fallen more than 77% under the weight of its 10-week and 20-week moving averages. While TPX attempted to breakout of this funk during the middle of 2008, the deepening of the credit crisis has hurt the company’s sales, sending the shares sharply lower. The equity is now trading below staunch overhead resistance at the 10 level. Furthermore, TPX’s 20-week moving average has taken up residence in the 10 region, and the security’s 10-week moving average has reversed course and is headed lower.

The stock is currently consolidating into support in the 7.50-8 region – site of its mid-July lows. However, a breach of this region could indicate that selling pressure is far from waning. As a result, if a trader can weather a potential short-term bounce in the shares into resistance at the 10 level, we could see TPX reverse course once again and head sharply lower.

Weekly chart of Tempur-Pedic International since October 2007 with 10-week and 20-week moving averages

The Sentiment Drivers

Turning to TPX’s sentiment backdrop, we find a considerable degree of negativity leveled against the shares. The stock’s Schaeffer’s put/call open interest ratio (SOIR) of 3.13 indicates that puts more than triple calls among near-term options. What’s more, this reading ranks above 88% of all those taken during the past year, meaning that options traders have been more bearish toward TPX only 12% of the time in the prior 52 weeks. However, given the stock’s poor technical performance, this negativity seems par for the course.

Elsewhere, short interest accounts for more than 40% of the stock’s total float. While this indicator could be a sign that TPX might benefit from a short-covering rally, recent data on this front says otherwise. Specifically, the number of TPX shares sold short plunged by 24% during the most recent reporting period. During the same 2-week time frame, the stock also fell sharply, meaning that the added buying pressure was easily outmatched by a wealth of selling. As a result, TPX is unlikely to benefit from continued short covering.

Sentiment indicators for Tempur-Pedic International

The Verdict?

I am beginning to see more and more stocks turn up with heavy investor pessimism and poor technical performance. Given the current situation on Wall Street, I am not surprised by this, but I have to believe that sooner or later this negativity has to unwind. Unfortunately for TPX, I don’t see that happening anytime soon. Remember that as a contrarian investor, I prefer to see stocks with sentiment that runs counter to the shares’ technical performance. For TPX, this just isn’t the case. That said, with the shares receiving a short-term bounce following earnings, there may be a better entry point for a TPX December 10 put next week. Clearly this doesn’t work if you are rolling out an October position due to expiration, but the trade is still worth considering if you have room in your portfolio.

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Copyright Schaeffer’s Investment Research. www.schaeffersresearch.com.